Buy in from the Greek public


I am a big fan of Angela Merkel.  She provides the strong leadership in the current phase of the GFC that was so lacking in the lead up to the collapse of Lehman Brothers.  But I think she made a big mistake in demanding that there be no referendum in Greece on the austerity and reform measures needed to secure a new round of bailout funding.  

After the negotiations on the terms of the second Greek bailout, on October 26 of last year, the then Prime Minister George Papendreou announced on 1 November his intention to hold a referendum on whether the required austerity measures should be pursued by the Greek Government.  The reaction of Merkel and Sarkozy was furious.  They made Papandreou travel to meet them in Luxembourg, gave him a public dressing down and then insisted that the referendum be scrapped.  Papandreou was critically weakened by this public humiliation and did not last much longer.  The commentariat’s reaction to this suppression of Greek democratic processes was generally favourable.  Papendreou’s plan was considered to lack courage and wisdom.  Many said the referendum proposal was utterly foolhardy.

But it is increasingly evident that Papandreou was right.  A referendum was essential.   There is no way to avoid a Greek withdrawal from the Eurozone, and the chaos that will attend it, without the buy-in of the Greek people.  Merkel and Sarkozy should acknowledge their mistake and  encourage a referendum in Greece as soon as is practically possible.

A referendum on the austerity measures would confront the electorate of Greece with a perfectly clear choice — austerity and reform or default and exit from the Eurozone.  It would turn the discussion away from navel gazing and blaming of foreigners to a public debate on the impending decision.  As the day of the referendum drew closer ordinary Greeks would have to settle in their minds whether they want austerity and reform or exit from the Euro.  The fact that there would be no other choice is a result of Merkel’s deserved reputation for steadfastness and strength.  The Greeks know that she will cast them into the outer darkness of exit from the Euro, if they do not undertake the necessary reforms and austerity.

A referendum would not allow the Greek people to kid themselves any more about the intractibility of their situation.  Greece would be plunged into crisis — leading to default and exit from the Euro — the very day after a vote against austerity.   Very few people would doubt that challenge that certainty by the end of the political campaign leading up to the referendum.

The referendum itself would have to articulate what ‘austerity and reform’ means.  Defining how much austerity and reform is needed to get complete buy-in from Germany for the rescue of Greece would also reduce a uncertainty a great deal.

In November of last most commentators seemed to think that the Greek people would vote against austerity.  I think a vote against austerity is quite unlikely.  It might be that public passions are so inflamed and the debate is so irrational that default would be voted for.  But in that case there is no hope for the bailout anyway and we may as well move to the next stage.


8 Responses to "Buy in from the Greek public"
  1. Why would a default mean an exit from the euro? Politicians posturing and employing scare tactics conflate the two on purpose, but they are separate issues.

  2. Hi Paul
    Why will a default force an exit from the Euro.  There are many reasons but the largest and most obvious is that the support of the ECB will be withdrawn.  That will cause the banking system to collapse.  There will be a run on deposits and non-payment of interest by borrowers — for sure.  The Greek Government will have to close the banks and will only be able to reopen them once it can reinflate them with the new currency.  
    Greece will soon be in default — once it agrees to a swap of short term high rate bonds for long term low rate bonds, there will have been a default on obligations to those bondholders.  It will not be recognised as a default by the International Swap Dealers Association, so it won’t trigger CDS payments but it is a default by any other name.   When I say that a vote a against austerity and reform will lead to default — I mean it will cause the shutting off of Greece from the European financial system — especially the ECB — which will cause a totally disorderly default and exit from the Euro.  

  3. Sam,
    I agree that in many ways Greece has been in a de facto default for a while now but dont see how a default would force an exit from the Euro. It is not clear what the ECB would do with Greek banks after a default of the government, nor is it certain that the role of Greek banks wont be taken over by foreign banks. One can also imagine the Greek government defaulting on all loans expect the ones to own banks.
    I understand that legally speaking, Greece can only exit the Euro by exiting the EU. Furthermore it takes time to reintroduce the old currency. All reasons to see defaults and euro exits as separate.

  4. A Greek default, while staying in the Euro, is a bad idea for Europe as a whole – Portugal and Spain will see how effective it is and also default.  In fact, all net debtor countries would be wise to follow suit.

    What do you mean Sam when you say the support of the ECB would be withdrawn?  Can they do that? Surely there a regulations in place that prohibit that.

    Also, if Greece defaults on 100% of their national debts plenty of institutions will want to lend them money again – even I would invest there.  It’s not like they will default two years in a row.  In fact, their probability of another default will be shifted to the distant future, so there won’t be a high premium on the price of borrowing for them.

    For Greece default followed by implementation of reforms that don’t involve immediate austerity would is the best way out, but is politically unattractive to the EU if other countries take part.

  5. Paul
    The idea that Greece will be forced out of the Euro if it choses default over austerity and reform is pretty widely accepted.  Wide acceptance doesn’t make it right, but it is kind of obvious.  
    Yes, with full ECB and German Government support Greece could default and remain in the Euro, but Merkel and made it completely clear that the price of default is exit.  
    A messy default will cause a run on the Greek banks.  When they go to the ECB for Euro liquidity to end the run, what collateral will they post for the Euro loans?  Greek Government bonds?  Greek corporate loans.  
    The run on the banks can only be ended by their closure and reopening with all assets and liabilities converted to Drachmas.  There is no way around this.   

  6. I suspect if you gave the Greek populace those two choices, they would vote to exit the Euro and damn the consequences. Just because it seems like the prudent economic choice to cop reform doesn’t mean it would be the choice that is made through democratic process. Politics is often irrational.

  7. Monty What is an example of an electorate voting for such an outcome.  The example is not allowed to use the benefit of hindsight — like the 30% of Germans who voted for Hitler — we have the benefit of hindsight that they did not have.   Sam  

  8. I just had a look at what the bookies make of this. Willem Buiter from Citybank gives the same basic scenario as I do (default without exit) but now gives a 50% chance of Greek exit the next 18 months. The bookies’ betting odds reflects a similar judgment: Greece unlikely to leave the euro this year (about 35%), but heavy odds-on to leave by 2015.
    Though the odds vary a lot over time on this one, the smart money is on no Grexit this year.

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